1. Tony\'s Pizzeria plans to issue bonds with a par value of $1,000 and 10 years

Question

1.

Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. The coupon rate on this bond is 9 percent annually, with interest being paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79. What is the YTM of the issue as a broker would quote it to an investor?

11%

10%

9%

8%

7%

2.

Which of the following statements is correct?

The constant growth DCF model can be used to value a stock only if the stock's dividends are expected to grow forever at a constant rate which is less than the required rate of return on the stock.

The constant growth DCF model may be written as k0 = D0/P0 + g.

The constant growth DCF model may be written as P0 = D0/(k + g).

The constant growth DCF model may be written as P0 = D0/(k - g).

3.

A share of perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12 percent rate of return, what should be the price of this preferred stock?

$57.25

$50.00

$62.38

$46.75

$41.64

4.

Alpha's preferred stock currently has a market price equal to $80 per share. If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha's preferred stock?

7.5%

13.3%

6.0%

$6.00

None of the above is a correct answe

5.

You are trying to determine the appropriate price to pay for a share of common stock. If you purchase this stock, you plan to hold it for 1 year. At the end of the year you expect to receive a dividend of $5.50 and to sell the stock for $154. The appropriate rate of return for this stock is 16 percent. What should be the current price of this stock?

$137.50

$150.22

$162.18

$98.25

$175.83

6.

The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

$44.00

$38.50

$40.00

$45.69

$50.00

7.

Ms. Manners Catering (MMC) has paid a constant $1.50 per share dividend to its common stockholders for the past 25 years. MMC expects to continue this policy for the next two years, and then begin to increase the dividend at a constant rate equal to 2 percent per year into perpetuity. Investors require a 12 percent rate of return to purchase MMC's common stock. What is the market value of MMC's common stock?

$14.73

$15.00

$15.58

$15.30

$12.20

Explanation / Answer

Since, there are multiple questions, the first four have been answered.

______________

Question 1:

The yield to maturity can be calculated with the use of Rat function/Formula of EXCEL/Financial calculator. The formula/function for rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Interest Payment, PV = Current Selling Price and FV = Face Value

_____________

Here, Nper = 10*2 = 20, PMT = 1,000*9%*1/2 = $45, PV = $937.79 and FV = $1,000 [we use 2 and 1/2, since the bond is semi-annual]

Using these values in the above formula, we get,

Yield to Maturity = Rate(20,45,-937.79,1000)*2 = 10% (which is Option B)

___________________

Question 2:

The constant growth DCF model can be used to value a stock only if the stock's dividends are expected to grow forever at a constant rate which is less than the required rate of return on the stock. (which is Option A)

___________________

Details Provided Below:

The formulas mentioned in Part B, C and D are incorrect as the correct formula for calculation of fair value/stock value today as per constant dividend growth model is:

Current Stock Price = D1/(ke - g) where D1 is dividend at the end of year 1, ke = cost of equity and g = constant growth rate.

This formula can be used to derive the cost of capital (ke) as well, but again we will not use D0. Instead we will be requiring D1 in the calculation.

Additionally Option A is correct, because if the dividend growth rate is equal to or more than the required return, it will not be possible to determine the stock price as it will result in an infinite or negative value which would be incorrect.

___________________

Question 3:

The price of the preferred stock can be determined with the use of following formula:

Preferred Stock Price = Annual Dividend/Expected Return

___________________

Using the values provided in the question, we get,

Preferred Stock Price = 6/12% = $50 (which is Option B)

___________________

Question 4:

The formula for calculating required return on preferred stock is:

Required Return = Annual Dividend/Current Stock Price

___________________

Using the values provided in the question, we get,

Required Return = 6/80*100 = 7.5% (which is Option A)

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